Feed: Some Basic Info Regarding Asset-Based Financing - AggScore: 14.0

Some Basic Info Regarding Asset-Based Financing

Usually, asset based loans have strict loan-to-value limits. These vary from lender to lender and depend on the type security. Indicatively, lenders may limit a loan to somewhere from 50% to 70% of the appraised value of the asset taken as security. For example, if the asset has an appraised value of $1.0 million, the asset based lender may lend up to $0.7 million against that asset. The precise meaning of the term appraised value is important.

Conventional lenders usually take the existing market price of an asset as its appraised value. Asset based lenders, by contrast, may consider appraised value to be best seen as the fundamental value. In these cases, asset based finance options can be attractive even for high quality borrowers. This point is highlighted in the example below.

Mainstream lenders usually set a loan amount with reference to the prevailing market price of an asset not its fundamental value. This can be unattractive for borrowers if the fundamental asset value is above the market price. In these cases, conventional loans can be unnecessarily restrictive and penalize borrowers that have identified opportunities to acquire assets at discounts versus fundamental value.

Assume a property investment professional has an opportunity to purchase a commercial property from a distressed seller at a price of $10.0 million. The property professional assesses this price to be at a deep discount of $8.0 million to the true underlying fundamental value of the property. In other words, the property professional estimates that fundamental value to be $18.0 million.

When evaluating loan applications, asset based lenders rely heavily on assets offered as collateral. This security is typically assigned a high weighting relative to the sustainable or underlying cash flow of the borrower. As a result, lenders set low priority on obtaining income or cash details flow from borrowers.

For higher-risk borrowers, asset based lenders may require the granted line of credit be established as a blocked account necessitating approvals by the lender before withdrawals can be made. This stipulation provides the lender with tight control over the funds and allows it to closely review their deployment.

Hedge funds may also engage in high value, asset based loans centered on large, discrete, and specialized assets. They typically participate in these transactions not as a stand-alone activity but rather to support a wider trading or transaction strategy. To illustrate, a firm that owns and operates a positive cash flow project needs new capital to increase capacity. It enters discussion with a hedge fund to arrange a loan with the project as collateral. The fund grants the loan after identifying the project is of interest to a number of potential buyers and assessed these buyers are likely to pay a premium above the loan amount extended to the current owner. Adverse market conditions eventually force the borrowing company into loan default; the hedge fund takes possession of the project and immediately divests it at a profit.

In conclusion, accounts receivable financing can appear competitively structured even to top grade, high quality borrowers. A critical issue to consider is the meaning placed on the term appraised value. Conventional lenders tend to consider appraised value as being equal to prevailing market or purchase price. By comparison, asset based lenders may be more prepared to accept that the purchase price can be below the fundamental value of an asset.